Injury to credit score depends on debt strategy

WASHINGTON — When you do a short sale of a house, or modify the mortgage, is there much of an impact on your credit score? What if you walk away from the mortgage altogether?

A scoring company created by the three national credit bureaus — Equifax, Experian and TransUnion — has some eye-opening numbers. VantageScore Solutions, whose risk-prediction scores are now being used by some of the largest mortgage companies and banks, has found that the way consumers handle their mortgage problems can have profound effects on their credit scores.

For example, some alternatives — such as loan modifications that roll late payments and penalties into the principal debt owed on the house — can actually increase borrowers' scores modestly. Refinancings of underwater, negative-equity mortgages — such as the Obama administration's “home affordable” refis through Fannie Mae and Freddie Mac — may have little or no negative impact on scores, even though the homeowners might have been tottering on the edge of serious delinquency before refinancing.

The Vantage score, the primary competitor to the long-dominant FICO score, rates borrowers on a scale ranging from 501 — subprime, highest risk — to 990, superprime, the lowest risk. Unlike FICO, where scores can vary by 50 to 100 points based on which bureau supplied the underlying credit data, Vantage scores are approximately the same for each consumer.

When homeowners negotiate a short sale with lenders, they sometimes assume there will be relatively little impact on their scores. After all, the loan was successfully paid off, there was no foreclosure, and the lender voluntarily agreed to accept a lower balance than was owed.

But in fact, according to VantageScore researchers, short sales can trigger big drops in scores. Sarah Davies, senior vice president of analytics, said a homeowner who previously had an excellent score of 862 might plummet 120 to 130 points immediately as the result of a short sale.

While it's true the lender may lose less money through a short sale compared with a foreclosure, Davies said in an interview, “it's still a derogatory event.” The full debt was not repaid. The lender lost money. Scores tanked.

What happens when borrowers walk away from their mortgage debts altogether, the “strategic defaults” that have become commonplace in some large markets, especially in California? They can count on 140- to 150-point immediate hits to their scores, plus negative marks on their credit bureau files for up to seven years.

People who file for bankruptcy protection covering all their debts — the mortgage, credit cards, auto loans, etc. — get hit with declines that are the scoring equivalent of a nuclear bomb: an average 355- to 365-point collapse in their scores. Bankruptcies remain on borrowers' credit bureau files for 10 years.

With all the mortgage delinquencies, short sales and foreclosures experienced by American consumers in the past couple of years, has there been a deterioration of average scores across the board? Absolutely.

For example, roughly 36.6 million of the 213 million consumers tracked by the three national credit bureaus in the first quarter of 2008 had Vantage scores above 900 — the superprime credit rung. That select group represented 17.2 percent of the country's consumers. But by the end of the second quarter of this year, just 15.4 percent — 33.3 million out of 216.9 million individuals' files — were left among the elite. By credit industry standards, that's huge.